Estimation risk versus optimality risk: An ex-ante efficiency analysis of alternative equity portfolio diversification strategies

Andrea Tarelli, Lionel Martellini, Vincent Milhau

Risultato della ricerca: Contributo in rivistaArticolo in rivistapeer review

Abstract

Implementing portfolio optimization techniques in practice is a challenging task because of the presence of estimation risk for the required parameters, namely expected returns and covariances. This paper provides a detailed empirical analysis of the trade-off between estimation risk, i.e., the risk of imperfect estimation for the required risk and return parameters, and optimality risk, the risk induced by investing in a heuristic portfolio strategy (e.g., an equally-weighted scheme) that requires fewer or no parameter estimates. Formally, we measure the opportunity costs related to estimation risk and optimality risk as the difference in ex-ante Sharpe ratios between the true maximum Sharpe ratio portfolio and the benchmark used in practice, which is plagued by the presence of estimation risk and/or optimality risk.
Lingua originaleEnglish
pagine (da-a)26-42
Numero di pagine17
RivistaRB BANKERS, MARKETS, INVESTORS
Stato di pubblicazionePubblicato - 2014

Keywords

  • Estimation risk, Portfolio choice

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